Complications of Rental Income and Expenses

As a tax accountant, I meet with clients who try to tally up income and expenses from their rentals couple days before their appointment to finalize taxes. That’s understandable but it is not recommended since there is a possibility that you might not have all the expense records.

According to the IRS, the “tax gap” exists because of the complications of reporting rental income and expenses. It is not just you; the tax law related to rentals is simply too complex.

There are three things you should know about rentals because the rules are little different from what you might expect.

Depreciation

In most cases, you can immediately expense an asset using expensing rules, also called Section 179. Using these rules, you write off the cost of business assets in the year you purchase them. Unfortunately, Section 179 is not available for residential rental property. Typically, you’ll depreciate residential rentals over 27.5 years. Appliances, carpeting, and furniture are depreciated over 5 years.

When rental expenses exceed income, the loss may not be deductible on your current year federal income tax return. Your income level and your participation in managing the property affect the deduction of any losses.

Losses you’re unable to use in the current year are “suspended.” Suspended losses can be applied against income from your rental in future years and can also reduce gain when you sell your property.

Sale of rental property

Depending on how you acquired your rental, the tax basis — the amount used to calculate gain or loss when you sell — may not be your cost.

For instance, say you used the property as your personal residence before renting it. In that case, your basis could be the fair market value of the home on the date you converted it to a rental instead of what you originally paid. Tax rules get really complicated if you turn your primary residence a rental and vice versa.

If you are dealing with rentals, it is always recommended you seek expert advice and consult with a competent and experienced tax professional.